[Federal Register Volume 63, Number 131 (Thursday, July 9, 1998)]
[Notices]
[Pages 37155-37157]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-18148]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40160; File No. SR-CBOE-98-25]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Board Options Exchange, Inc., Relating to a 
Change in Position and Exercise Limits for Equity Options

July 1, 1998.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on June 8, 1998, the Chicago Board Options 
Exchange, Inc. (``CBOE'' or ``Exchange'') filed with the Securities and 
Exchange Commission (``Commission'' or ``SEC'') the proposed rule 
change as described in Items I, II and III below, which Items have been 
prepared by the self-regulatory organization. The Commission is 
publishing this notice to solicit comments on the proposed rule change 
from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The CBOE proposes to increase the position and exercise limits on 
equity options traded on the Exchange to three times their current 
levels.
    The text of the proposed rule change is available at the Office of 
the Secretary, CBOE and at the Commission.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has prepared summaries, set forth in sections A, B and C below, of the 
most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The CBOE is proposing to increase the position and exercise limits 
for equity options traded on the Exchange to three times their current 
levels. Currently, Rule 4.11 subjects equity options to one of five 
different position limits depending on the trading volume and 
outstanding shares for the underlying security. Rule 4.12 establishes 
exercise limits for the corresponding options at the same levels.\3\ 
The limits are: 4,500; 7,500; 10,500; 20,000; and 25,000 contracts on 
the same side of the market. Under the proposed changes the new limits 
will be: 13,500; 22,500; 31,500; 60,000; and 75,000. The Exchange 
believes sophisticated surveillance techniques at options exchanges 
adequately protect the integrity of the markets for the options that 
will be subject to these increased position and exercise limits.
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    \3\ CBOE Rule 4.12 states: ``no member shall exercise, for any 
account in which it has an interest or for the account of any 
customer, a long position in any options contract where such member 
or customer, acting alone or in concert with others, directly or 
indirectly has or will have exercised within any five consecutive 
business days aggregate long positions in any class of options dealt 
in on the Exchange in excess of'' the established limits set by the 
Exchange.
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Manipulation.

    The CBOE believes that position and exercise limits, at their 
current levels, no longer serve their stated purpose. The Commission 
has stated that:

    Since the inception of standardized options trading, the options 
exchanges have had rules imposing limits on the aggregate number of 
options contracts that a member or customer could hold or exercise. 
These rules are intended to prevent the establishment of options 
positions that can be used or might create incentives to manipulate 
or disrupt the underlying market so as to benefit the options 
position. In particular, position and exercise limits are designed 
to minimize the potential for mini-manipulations and for corners or 
squeezes of the underlying market. In addition, such limits serve to 
reduce the possibility for disruption of the options market itself, 
especially in illiquid options classes.\4\
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    \4\ Exchange Act Release No. 39489 (December 24, 1997), 63 FR 
276 (January 5, 1998) (CBOE-97-11) (order approving an increase in 
OEX position and exercise limits).

On the twenty-fifth anniversary of listed options trading, the Exchange 
believes that the existing surveillance procedures and reporting 
requirements at options exchanges and clearing firms that have been 
developed over the years are able to properly identify unusual and 
illegal trading activity. In addition, the CBOE believes that routine 
oversight inspections of CBOE's regulatory programs by the Commission 
have not uncovered any material inconsistencies or shortcomings in the 
manner in which the Exchange's market surveillance is conducted. These 
procedures entail a daily monitoring of market movements

[[Page 37156]]

via automated surveillance techniques to identify unusual activity in 
both the options and underlying stock. Further, the Exchange believes 
the significant increases in unhedged options capital charges resulting 
from the September 1997 adoption of risk-based haircuts and the 
Exchange margin requirements applicable to these products under 
Exchange rules serves as a more effective protection than position 
limits.\5\
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    \5\ See Exchange Act Release No. 38248 (February 6, 1997), 62 FR 
6474 (February 12, 1997) (adopting Risk Based Haircuts); and CBOE 
Rule 12.3 Margins.
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    Furthermore, large stock holdings must be disclosed to the 
Commission by way of Schedule 13D or 13G.\6\ Options positions are part 
of any reportable positions and cannot be legally hidden. In addition, 
Exchange Rule 4.13--which requires members to file reports with the 
Exchange for any customer who held aggregate long or short positions of 
200 or more option contracts of any single class for the previous day--
will remain unchanged and an important part of the Exchange's 
surveillance efforts.
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    \6\ Exchange Act Rule 13d-1.
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    Position and exercise limits restrict legitimate options use. In 
the Exchange's view, equity position limits prevent large customers 
like mutual funds and pensions funds from using options to gain 
meaningful exposure to individual stocks, resulting in lost liquidity 
in both the options market and the stock market. The Exchange further 
believes that equity position limits also act as a barrier to the use 
of options by corporations wishing to implement options strategies with 
their own stock. For example, existing equity position limits could 
restrict the number of put options that could be sold under a corporate 
buyback program.\7\
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    \7\ The Commission notes that issuers would, of course, need to 
comply with all applicable provisions of the federal securities laws 
in conducting their share repurchase programs.
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    Financial requirements. The Exchange believes that financial 
requirements imposed by the Exchange and by the Commission adequately 
address concerns that a member or its customer may try to maintain an 
inordinately large unhedged position in an equity option. Current 
margin, and risk-based haircut metholodogies serve to limit the size of 
positions maintained by any one account by increasing the margin and/or 
capital that a member must maintain for a large position held by itself 
or by its customer. It should also be noted that the Exchange has the 
authority under paragraph (h) of Rules 12.3 and 12.10 to impose a 
higher margin requirement upon the member or member organization when 
the Exchange determines a higher requirement is warranted. In addition, 
the Commission's net capital rule, Rule 15c3-1 under the Exchange Act, 
imposes a capital charge on members to the extent of any margin 
deficiency resulting from the higher margin requirement.
    Past increases have had no adverse consequences. Equity position 
limits have been gradually expanded from 1,000 contracts in 1973 to the 
current level of 25,000 contracts for the largest and most active 
stocks. In 1997, the SEC approved the elimination of position and 
exercise limits in FLEX Equity options under a two-year pilot 
program.\8\ To date, there have been no adverse affects on the market 
as a result of the past increases in the limits for equity options or 
the elimination of position and exercise limits for FLEX Equity 
options.
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    \8\ See Exchange Act Release No. 39032 (September 9, 1997), 62 
FR 48683 (September 16, 1997) (order approving SR-CBOE-96-79).
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    Changes will allow options exchanges to compete more fairly with 
OTC markets. The Commission has stated that ``limits must not be 
established at levels that are so low as to discourage participation in 
the options market by institutions and other investors with substantial 
hedging needs or to prevent specialists and market-makers from 
adequately meeting their obligations to maintain a fair and orderly 
market.''\9\ However, in today's market, equity position limits put 
listed options at a competitive disadvantage to over-the-counter 
derivatives. OTC dealers can execute options trades through overseas 
subsidiaries not subject to NASD regulation, and therefore not subject 
to position limits. As a result, the largest trades can go unobserved 
and unmonitored for regulatory and oversight purposes. Member firms 
continue to express concern to the Exchange that position limits on 
CBOE products are an impediment to their business and that they have no 
choice but to move their business to off-shore markets where position 
limits are not an issue.
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    \9\ See H.R. Rep. No. IFC-3, 96th Cong., 1st Sess. At 189-91 
(Comm. Print 1978).
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    In addition, the NASD has recently filed a proposed rule change 
with the Commission \10\ which proposes to raise the position limits 
for conventional equity options (i.e., those options not issued, or 
subject to issuance by the Options Clearing Corporation) to three times 
their current levels (which is the same as three times the levels 
established by current Exchange rules for standardized options). 
Because conventional options often have nearly the identical terms as 
standardized, Exchange-traded options, the Exchange believes the 
position limits for standardized options should be at least as high as 
those for conventional options.
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    \10\ See Exchange Act Release No. 39893 (April 21, 1998), 63 FR 
23317 (April 28, 1998) (notice of SR-NASD-98-23). The Commission 
notes that the NASD's position limit filing was approved on June 12, 
1998. The NASD's position limit filing established position and 
exercise limits for conventional equity options identical to those 
being proposed by CBOE in this filing. See Exchange Act Release No. 
40087 (June 12, 1998), 63 FR 33746 (June 19, 1998).
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    The proposed changes should help to attract business back to the 
Exchange where the trades will be subject to reporting requirements and 
surveillance. In its release approving the elimination of FLEX equity 
option limits for a two-year pilot period,\11\ the Commission stated 
that the elimination of position limits will allow the listed options 
markets to better compete with the OTC market.

    \11\ See Exchange Act Release No. 39032 (September 9, 1997), 62 
FR 48683 (September 16, 1997).
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    [T]he elimination of position and exercise limits for FLEX 
equity options allows the Exchanges to better compete with the 
growing OTC market in customized equity options, thereby encouraging 
fair competition among brokers and exchange markets. The attributes 
of the Exchanges' options markets versus an OTC market include, but 
are not limited to, a centralized market center, an auction market 
with posted transparent market quotations and transaction reporting, 
parameters and procedures for clearance and settlement, and the 
guarantee of the OCC for all contracts traded on the Exchanges.\12\

    \12\ Id. at 48685. The Commission notes that approval of the 
elimination of position and exercise limits for FLEX equity options 
was granted for a two-year pilot period and was based on several 
other factors including, in large part, additional safeguards 
adopted by the exchanges to allow them to monitor large options 
positions.
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    It should also be noted that individual stocks are not subject to 
position limits. Investors can theoretically hold 100% of a company's 
shares outstanding as long as they file the appropriate Schedule 13D or 
13G. The Exchange believes the increase in the position and exercise 
limits will better enable the Exchange to compete against the OTC 
markets and is an appropriate and responsible increase given the nature 
of the Exchange's surveillance.
2. Basis
    The Exchange believes that the proposal is consistent with Section 
6(b) \13\ of the Act, in general, and Section

[[Page 37157]]

6(b)(5) \14\ of the Act, in particular, in that it is designed to 
promote just and equitable principles of trade and to protect investors 
and the public interest.
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    \13\ 15 U.S.C. 78f(b).
    \14\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments on the proposed rule change were neither solicited 
nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) by order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room, located at the above address. 
Copies of such filing will also be available for inspection and copying 
at the principal office of the self-regulatory organization. All 
submissions should refer to File No. SR-CBOE-98-25 and should be 
submitted by July 30, 1998.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-18148 Filed 7-8-98; 8:45 am]
BILLING CODE 8010-01-M